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Kansas And Missouri Show The Dangers Of Tax Competition

Tax competition isn’t just an international issue. While recent headlines have focused on how the high U.S. corporate rate is causing multinationals to relocate to jurisdictions that have cut their taxes or restructured their tax regimes to be more favorable to business (like Ireland and the United Kingdom), the effects of a race to the bottom have been more dramatic close to home. For the last two decades, U.S. states have found themselves competing with their neighbors to attract domestic investment and relocations. And as Missouri and Kansas are learning, the real losers in tax competitions are taxpayers and state budgets.

Led by conservative Republican Gov. Sam Brownback, Kansas sharply cut its income tax in 2012. The state slashed its rate from 6.45 percent to 4.9 percent. The Kansas Legislature wasn’t satisfied, however. It followed that up with a plan in 2013 to drop the rate to 3.9 percent by 2018. The tax reform legislation eliminated taxes on passthrough income, something that was designed to encourage the formation of new businesses.

Kansas’s aggressive tax plan encouraged Missouri Republicans to push for the same. “If Missouri does not fundamentally change our tax policy, we will fall behind states like Kansas, Oklahoma, and other neighbors who are reforming their tax systems,” said State Sen. Will Kraus (R). The GOP-controlled Legislature took Kraus’s advice and passed a tax cut plan in 2013 that was vetoed by Democratic Gov. Jay Nixon. This spring, the Legislature tried again and was able to override Nixon’s veto.

Missouri’s plan will gradually lower the income tax rate from 6 percent to 5.5 percent, still above Kansas. It includes a special deduction for business income on personal tax returns, something that’s available in only two other states. Other bills that would have granted some sales tax exemptions to particular industries were vetoed by Nixon, but lawmakers are expected to override the governor in the September session.

The Kansas tax reform plan hasn’t exactly worked out in Brownback’s favor. The state has been hemorrhaging revenue, losing $334 million in April, May, and June. New business filings have been up, but because of forfeitures and closures, Kansas actually has fewer registered businesses now than during the recession. The state’s credit rating has been cut by two agencies. The tax cuts might cost Brownback reelection. He performed poorly against a poorly funded challenger in the Republican primary, and polls show Paul Davis, the Democratic challenger, running close. Davis has pledged to freeze the tax cut plan if elected.

Some in Missouri now fear they are next, according to USA Today. And they should be concerned. It isn’t all that clear that supply-side policies work on the federal level, but economic growth almost never significantly offsets state revenue losses from tax cuts. Virtually every state that has aggressively cut taxes in the last several decades has faced budget deficits that forced a suspension of the cuts (like in Virginia) or forced them to look for other sources of revenue. Kansas is just the latest example.

Governments don’t win when they engage in tax competition. On the international level, Ireland and the United Kingdom’s transformation into tax havens hasn’t magically solved their budget crises. Nor has it really created much in the way of new jobs. The experience at the state level isn’t any different. Cutting taxes does put pressure on other jurisdictions, creating a kind of prisoner’s dilemma on taxes. It just isn’t clear whether the outcome is all that favorable for taxpayers, given the sacrifices that states must make to pay for tax reduction.

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But how can this be? Everyone knows that lower taxes bring in greater revenue, that’s what the laffer curve says. Also, lower taxes are better for business and reduce the size of government which is inherently good for the state economy.